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No one needs to be reminded that pension funds have taken a big hit
over the course of this crisis. As Yeva Nersisyan and I have
shown, for private pensions, the value of
accumulated assets falls short of meeting promised pay-outs of
defined benefit pension plans by about a fifth, amounting to a
$400 billion shortfall. Public pensions provided by state and
local governments have a shortfall estimated to run as high as $2
trillion. On any reasonable accounting standard, the PBGC
(Pension Benefit Guarantee Corporation) is troubled because its
reserves will be wiped out by the failure of just a couple of
large firms on “legacy” pensions.

There has been a long-term trend to convert defined benefit plans
to defined contribution plans—which means that workers and
retirees take all the risks. Indeed, this is often the outcome
for “legacy” defined benefit plans that require bail-outs. In
spite of some attempts to improve management and transparency of
pension funds, it likely that the PBGC, itself, will need a
government bail-out, and retirees will certainly face a more
difficult future.

The total volume of pension funds grew rapidly over the postwar
period, especially since the late 1970s, and are now huge
relative to the size of the economy (and relative to the size of
financial assets). The dot-com bust as well as the current crisis
have hit pensions hard. The attached figure figure shows private
and public pension funds relative to GDP.

Obviously, pension funds suffer when financial markets crash. It
is important to understand, however, that this is a two-way
street: pension funds have become so large that they are capable
of literally “moving markets”. As they flow into a new class of
assets, the sheer volume of funds under management will cause
prices to rise. Pension funds often follow a strategy through
which they allocate a percent of funds to a particular asset
class, and this can occur on a “follow the leader” basis. This
pushes up prices, rewarding the decision by fueling a speculative
bubble. Of course, trying to reverse flows—to move out of a class
of assets—will cause prices to fall, rapidly. Pension funds
contributed mightily to the commodities market bubble and crash a
couple of years ago.

Just before the current global crisis hit, pension funding was,
on average, doing well—thanks to the speculative bubble. To
restore funding levels, pensions need a new bubble. Indeed, they
are looking into placing bets on death through the so-called life
settlements market (securitized life insurance policies that
pay-off when people die early). Ironically, this would be a sort
of doubling down on death of retirees—since early death reduces
the amount of time that pensions have to be paid, even as it
increases pension fund assets. Or, perhaps, securitized “peasant
insurance” (contracts taken out by employers on their workers
that pay-out in the case of early death). Or securitized
developer “turn-over” fees—1% of the sales price of homes every
time they are sold for the next 99 years. Whatever that bubble
will be, pensions will need it to temporarily restore their
finances.

To conclude, pension funds are so large that they will bubble-up
any financial market they are allowed to enter—and what goes up
must come down. The problem really is that what Hyman Minsky
called managed money (including pension funds, sovereign wealth
funds, university endowments, money market funds, etc), taken as
a whole, is simply too large to be supported by the nation's
ability to produce output and income necessary to provide a
foundation for the financial assets and debts that exist. Hence,
returns cannot be obtained by making loans against production (or
even income) but rather can be generated only by
“financialization”—or layering and leveraging existing levels of
production and income. This is why the ratio of financial assets
and debts grows continually—and why managed money has to
continually innovate new kinds of assets in which to speculate.

The New York Times reported on September 17 that several states
have found an accounting gimmick that apparently improves the
actuarial status of their pension funds. (www.nytimes.com/2010/09/18/business/18pension.html)
This will sound familiar to anyone who has been following the
various tricks employed by, say, Goldman Sachs to hide debt.
States slash benefit for future workers and record savings today.
Obviously it is very difficult to cut pensions of existing
workers—but it is relatively easy to cut the benefits or raise
the retirement ages of unborn workers! Since they cannot protest,
why not shore up today's pension funds by promising to cut
pensions of workers who won't be hired for decades?

Now, if those future savings are discounted back to the present,
they do not amount to much. But state actuaries have been using
the lower pension costs, applied to today's workers who have
suffered no such cuts. This dramatically reduces the amount that
must be set aside in pension funds. That also makes state
finances look better overall, which earns higher credit ratings
and lowers the cost of borrowing today. Of course, it vastly
overstates the condition of the pension funds. The SEC has
accused New Jersey of securities fraud, and might go after other
states, including Illinois, Rhode Island, Texas, and Arkansas
that have used similar tricks to make their pension funds look
better.

Ironically, the Trustees of Social Security use these tricks to
make Social Security's finances look worse! This aids and abets
the enemies of the program, who have never tired in their efforts
to destroy Social Security. Here's how they do it. They claim
that over a 75 year horizon, Social Security is just as bankrupt
as are private pensions; and over an infinite horizon its
shortfall amounts to trillions of dollars. Thus, they claim, the
only solution is to cut benefits and raise payroll taxes today.
Exactly the opposite accounting machinations employed by state
governments to make their pensions look good.

Unlike private pension plans or state and local government
pensions, Social Security is a federal program backed by the full
faith and credit of the US Treasury. It cannot go bankrupt, and
it cannot really face a shortfall. And unlike a private pension
plan or a state and local pension plan, the entire productive
capacity of the United States is potentially available to support
the guarantees made to beneficiaries. Guarantees made to General
Motor's retirees depend on the earning capacity of GM as well as
any pension funds accumulated to be liquidated in future years at
a good enough price to cover promises. As GM's market share
declines it becomes increasingly difficult to meet its promises
to retired workers. And if market prices of the assets
accumulated in its pension fund decline, retiree benefits will be
hard to cover. Ditto, to a degree, the retirees who worked for
the Great State of Missouri—which might find that its tax revenue
cannot make up for losses on its pension fund assets. Social
Security, as a Federal government program relies on the fiscal
capacity of our national government to provide nominal benefits,
but more importantly, on the real productive capacity of our
economy to provide the real benefits to tomorrow's seniors,
workers, and other dependents. For that reason, Social Security's
financing is irrelevant to its prospects for meeting its
promises.

Yes, the Trustees are mandated to report expenditures on benefits
and revenues from payroll taxes (as well as interest earned on
Trust Funds). On a flow basis, Social Security typically runs a
huge surplus (the current deep recession has lowered tax revenues
significantly, but recovery will restore the surplus). The
Trustees, however, decided to provide a calculation of discounted
expenditures and revenues over a 75 year horizon. They provide
three estimates: optimistic, pessimistic and midrange. On the
optimistic assumptions, the program's revenue always exceeds
expenditures through the entire 75 year period; the other two
scenarios show deficits at some point in the future. The
optimistic projections are almost never discussed in polite
society—since Social Security's enemies prefer estimates that
show “unfunded entitlements” of trillions of dollars.

But here's the deal. These calculations are nothing more than an
exercise in mental masturbation. It does no good to reduce Social
Security benefits paid to today's retirees—the problem, if there
is a problem, comes decades into the future. In 2050 it is
conceivable that payroll tax revenue will be lower than benefits
paid, meaning that Uncle Sam will be committed to covering the
difference. He might decide at that time to cut benefits, raise
taxes, or run a deficit. Nor would it help to raise taxes
today—that would simply increase surpluses today that take the
form of a claim on Uncle Sam that he will “balance” by cutting
benefits, raising taxes, or running a deficit in 2050.

Hey, why not follow the states? Let us mandate lower Social
Security benefits and higher payroll taxes in the year 2050!
Abracadabra, unfunded entitlements disappear!

Of course, whatever we do today will not really constrain what
our grandkids decide to do in 2050. They can repeal the benefit
cuts and tax hikes scheduled to take place. And they are the ones
who, in any case, will have to decide what to do with their
seniors. Who knows, they might indeed be much more stingy than we
are—maybe they will decide to let their parents and grandparents
live in poverty, surviving by dumpster diving and living in
cardboard crates. But they can do that without our mandated cuts
and tax hikes.

Here is the reality I see: defined benefit pension plans (whether
private or state and local government) are going to go the way of
the Dodo bird. It is simply not possible for firms to compete in
a global economy in which most of our competitors do not rely on
private pension guarantees for retirement. And our state and
local governments will not be able to cope with the demands
placed on them by an aging society in which state and local
government tax revenues need not grow as fast as the retired
population of government employees. These programs only worked in
the early postwar economy that had a huge population of
babyboomers with relatively rapid growth of output as well as of
state and local government tax revenue. Government employment
grew, as well as employment in our nation's factories. That is
long over.

Defined contribution plans similarly worked only so long as we
maintained the fiction that financial assets and liabilities
could grow at a much faster pace than our nation's output. In the
past decade, that required serial bubbles. That, too, is now
over. There is a role to be played by private retirement savings
and by public pensions, but it must be much smaller—on a scale
commensurate with our ability to produce.

What we now need to realize is that the Social Security leg of
our retirement stool will play the biggest role for most of
tomorrow's seniors. Effectively what Social Security will do is
to tax tomorrow's workers so that they cannot consume all of
tomorrow's output. And it will pay benefits to tomorrow's seniors
so that they can buy some of tomorrow's output. Exactly how that
division of tomorrow's output will be made is a decision that
must be made by tomorrow's voters. All that we can do today is to
try to keep our economy strong, educate our young people so that
they will be productive tomorrow, and improve our longest-lived
public infrastructure.

L. Randall Wray is a Professor of Economics, University of
Missouri—Kansas City. A student of Hyman Minsky, his research
focuses on monetary and fiscal policy as well as unemployment and
job creation. He writes a weekly column for Benzinga every
Thursday.

He also blogs at New Economic Perspectives, and is a
BrainTruster at New Deal 2.0. He is a senior scholar at the
Levy Economics Institute, and has been a visiting professor at
the University of Rome (La Sapienza), UNAM (Mexico City),
University of Paris (South), and the University of Bologna
(Italy).